The core topic I need to discuss is the inherent deflationary aspect of bitcoin. Imagine trying to do a futures contract with a currency whose value is rapidly changing. Now imagine demand for that currency rising because more individuals want to use the currency. The current design of bitcoin specifies a fixed amount of coins to ever be created. So for contracts of a period of 1 year, the use of bitcoin would be a problem, as far as I currently understand.

I assume it would be too disruptive to add monetary controls to bitcoin, as many don't want to correct this problem because they have profited from it and have much investing in the model of a guaranteed fixed supply. Therefore I assume a fork of bitcoin for the specific use case is more likely, IF it can be made to work for the intended purpose.

I have some rough ideas for enhancements to the bitcoin design, and my main task at hand is to determine if they are feasible. Hence the desire to hire an expert.

I believe I have a p2p voting method outlined that would utilize the block chain. Assume voting were possible where 'protocol variables' could be set. Those variables would be included in the blockchain after the voting process is concluded. The voting would be a deterministic p2p process.

The goal would be to vote as a community on monetary policy, with the goal of keeping the value stable, since this community will have a genuine need for long term stability.

Predictable deflation is not a problem because it's already built into the present price. Every "people will want to hold onto bitcoins rather than spend them" argument is perfectly counterbalanced by a "people will want to induce others to part with bitcoins" arguments.

The fundamental flaw in the deflation argument is that it assumes bitcoins are worth X today and then they have some extra value from the expected deflation that will make people want to hold them. If that were true, then they would have to be worth more than they are worth, which is a contradiction. If you want to argue they have some "extra" value from deflation, that would be extra value on top of their present value *less* the deflation value. (X-Y)+Y is just X.

10 bitcoins today includes the right to have 10 bitcoins next year, plus the additional right to spend them before that if that's more valuable. So 10 bitcoins today cannot possibly have a lower present value than 10 bitcoins next year.

I am an employee of Ripple.1Joe1Katzci1rFcsr9HH7SLuHVnDy2aihZ BM-NBM3FRExVJSJJamV9ccgyWvQfratUHgN

The supply of bitcoins is only (to a reasonable approximation) going to increase; never decrease.

Therefore any price deflation that happens because bitcoins increase in value because of increased demand is dependent entirely on the success or not of bitcoins. Therefore bitcoin deflation is not predictable, therefore the current price does not include that deflation.

The part that really bakes my noodle though is that the same argument for current price including predictable deflation applies exactly for current price included predicted increase in value. Which means that the current price reflects the market's prediction of future price. The noodle bake part being: surely that means the current price is the predicted future price?

This thread explains the relationship between price and deflation brilliantly - it's the first time I've seen it put into words so effectively, so thanks!

Quote

The part that really bakes my noodle though is that the same argument for current price including predictable deflation applies exactly for current price included predicted increase in value. Which means that the current price reflects the market's prediction of future price.

That's the "efficient market" theory, isn't it? http://en.wikipedia.org/wiki/Efficient-market_hypothesis That assumes that the market participants are correct in their prediction. If you think you know better, then you may believe the price is either too low or too high, in which case you may have an opportunity to invest.

However, if you think that the current price is (for example) overvalued from it's "true value", the market price might still move further from the true value due to a change in circumstances, and the "true value" may change before it's ever reached, which makes the term "true value" a bit useless.

Quote

The noodle bake part being: surely that means the current price is the predicted future price?

I don't think the current price is the predicted future price at all - instead, it's a combination factoring in the potential gain from increases in value and the potential loss due to a collapse (due to technical, legal, or social reasons), combined with the demand from its utility for trade. Surely, the potential gain could be enormous if Bitcoin became mainstream, but most people are obviously cautious enough to not invest too heavily in it so the price is not currently skyrocketing.

Therefore any price deflation that happens because bitcoins increase in value because of increased demand is dependent entirely on the success or not of bitcoins. Therefore bitcoin deflation is not predictable, therefore the current price does not include that deflation.

The current price includes the expected deflation multiplied by the expected probability that this deflation will occur. It's possible that bitcoin value will drop to zero before they have a chance to deflate for a variety of reasons. The issue is what happens in the future if all bitcoins have been generated and bitcoins are a well-established means of payment. In that case, deflation will be predictable.

Quote

The part that really bakes my noodle though is that the same argument for current price including predictable deflation applies exactly for current price included predicted increase in value. Which means that the current price reflects the market's prediction of future price. The noodle bake part being: surely that means the current price is the predicted future price?

Not exactly. The present price includes the discounted value of all expected future prices. The present price is the notional sum of a series of partial values. You can think of it this way:

The price of a bitcoin today is the sum of:1) The value of having a bitcoin today but having to pay out a bitcoin tomorrow.2) The amount you would be willing to pay today to get a bitcoin tomorrow but have to give it back the next day.3) The amount you would be willing to pay today to get a bitcoin the day after tomorrow but have to give it back the next day.and so on.

Note that all the partial values you sum are present values. For example, say we all expected gold to be worth $5,000/oz next year. And say you would be willing to pay $4,700 today to get $5,000 next year. Then the price of gold today will not be less than $4,700. In fact, it will be roughly $4,700 plus the value of being able to borrow an ounce of gold for a year.

Quote from: bizzy

That assumes that the market participants are correct in their prediction. If you think you know better, then you may believe the price is either too low or too high, in which case you may have an opportunity to invest.

Well, the question is whether it's a problem if there's universal belief that a currency will deflate -- won't that make everyone want to hold it. And the answer is no for two reasons: First, it will also make everyone want to induce others to give it to them. Second, if everyone knows it will deflate, then you have an efficient market. If it only might deflate, then there's no problem either because anything might deflate.

Of course, there will never be perfect prediction. But the fact that most people will generally agree on at least what is likely to happen and that such predictions will not change radically over short periods of time ensure a stable price. (And the premise of the question is that we all know bitcoins, if they survive that long, will ultimately be deflationary. If that premise is false, there's no problem. If the premise is true, the market will be efficient to the extent it's true, so still no problem.)

I am an employee of Ripple.1Joe1Katzci1rFcsr9HH7SLuHVnDy2aihZ BM-NBM3FRExVJSJJamV9ccgyWvQfratUHgN

But the fact that most people will generally agree on at least what is likely to happen and that such predictions will not change radically over short periods of time ensure a stable price

I disagree that there's that agreement - I think most people have very little idea about the future prospects (and many don't care, as long as they get paid to mine), which is why the market price isn't skyrocketing at the moment, but instead people accept there is a risk (without being able to put a number on it). The price might appear stable right now, but I'd be willing to bet it won't stay that way for long.

But the fact that most people will generally agree on at least what is likely to happen and that such predictions will not change radically over short periods of time ensure a stable price

I disagree that there's that agreement - I think most people have very little idea about the future prospects (and many don't care, as long as they get paid to mine), which is why the market price isn't skyrocketing at the moment, but instead people accept there is a risk (without being able to put a number on it). The price might appear stable right now, but I'd be willing to bet it won't stay that way for long.

I agreee. That's not the case right now. The question is about a future time when that is the case, when bitcoins are stable, when all (or most) of the coins are mined, and so on.

Right now, in two years bitcoins might be worth nothing or $5,000 each.

I am an employee of Ripple.1Joe1Katzci1rFcsr9HH7SLuHVnDy2aihZ BM-NBM3FRExVJSJJamV9ccgyWvQfratUHgN

Monetary policy control only works with a currency which is decreasing in value (People will not hoard the currency but spend/invest), thus central bank can have a good idea about how much liquidity is in the market, and using appropriatery open market operations to increase/decrease money supply

But if people are hoarding the currency, then most of the added money supply will become their saving, and the monetary policy could have very little effect.

Dogisland said:"By monetary controls would you be looking to change the bitcoin supply rate to keep the currency at a constant price ? e.g. $10"

Yes for expansionary policy, but within a set range. But also by control over fees to both control velocity and contract the supply of the currency (by destroying it).

I'm assuming the following: 1. The demand for the currency will increase if the project that uses it is successful. 2. The project is all about long term contracts, let's use 1 year as an example. For buying and selling items today, bitcoin is great. But let's say you want a hosting provider to accept x amount of bitcoins each month for 1 year, what will be their response? I predict it will be resistance if they believe the value of the coins will increase (deflation) over the next year. They will be on the loosing side. Now think of a 30 year mortgage, bitcoins would not be used for the same reason. 3. If the 51st state joined the USA, there would be a need to create more dollars simply to balance the increased demand for the currency. Just as a growing animal needs more blood because of an increase in mass just to keep the same flow, pressure, and other attributes. Think of a growing company that can outgrow its cashflow, it's a similar situation. Bitcoin can not adjust for this.

So my situation is that a global digital currency is needed, but it needs monetary controls. They don't need to be perfect, but they need to be able to exercise a psychological effect to deter speculators, just as a centrally managed currency can. It would not be centrally managed though, but rather a p2p voting scheme would decide as a consensus. Note I'm not 100% sure I trust the masses to make correct monetary policy, but for this project it would be businesses, so I'm not as concerned.

"Would it not be a simple case of matching buyers and sellers ?"

That's a fallback position we're probably going to take, but if a contract were traded between currencies, then an exchanger would take a cut. This greatly reduces the velocity of the contract, as it can't be exchanged much else the fees kill it's value. We need to be able to cross borders easily.

Joel said:"Predictable deflation is not a problem because it's already built into the present price."

Disagree, because there is no accurate mechanism today to predict the future value of a bitcoin. For example, if the DEA took down a major money transport network (not laundering) tomorrow, the demand for bitcoins could spike. The market would know this I feel, therefore nobody in their right mind would accept a long term contract that had bitcoins as the currency. That's the essence of the problem I see with bitcoin, it's for short term transactions only because of a lack of confidence in the future stability of the currency.

" Every "people will want to hold onto bitcoins rather than spend them" argument is perfectly counterbalanced by a "people will want to induce others to part with bitcoins" arguments. "

Disagree, because recent history disproves this. Bitcoins have suffered much deflation. Perhaps the mt gox attack popped a bubble even.

"The fundamental flaw in the deflation argument is that it assumes bitcoins are worth X today"

They clearly are I think it's about $13 per bitcoin.

"and then they have some extra value from the expected deflation that will make people want to hold them."

They do, which is why Satoshi is sitting on a lot of them. He knows the demand will only rise and the supply will be much more constant. As the delta between them increases, the value of his coins is guaranteed to increase. Hence a hold strategy.

"If that were true, then they would have to be worth more than they are worth, which is a contradiction."

This does not factor in risk, nor the inability to predict bitcoin values. Satoshi has a greater ability to predict than many others, hence he's more of an investor than a speculator, but prediction with bitcoin is speculation at best at the moment because of it's nature and the fact that it's in its infancy.

" 10 bitcoins today includes the right to have 10 bitcoins next year, plus the additional right to spend them before that if that's more valuable. So 10 bitcoins today cannot possibly have a lower present value than 10 bitcoins next year."

I dont agree that a present value analysis is reasonably possible, so I must reject that part of your argument.

I am very thankful for your reply.

Realnowhereman said:"There is no predictable deflation "built in" to bitcoin."

Disagree. The future supply is fixed per the algorithm. IF demand increases, the result is deflation. It has already occurred. I consider this fact.

"The supply of bitcoins is only (to a reasonable approximation) going to increase; never decrease."

I feel that's not relevant because only the delta between supply and demand is the issue, and it can be unhealthy. The Yen had a deflation problem recently, and it was horrible for Japan's economy because it's export based. The supply of real estate could be used in your example also because it's fixed, yet I also don't feel your argument is relevant in the case of real estate.

"Therefore any price deflation that happens because bitcoins increase in value because of increased demand is dependent entirely on the success or not of bitcoins. Therefore bitcoin deflation is not predictable, therefore the current price does not include that deflation."

Agreed, mostly. My fundamental assumption is that demand for bitcoins will grow, because bitcoin will succeed. But it will never in its current form be usable for long term transactions because of the inability to exercise monetary policy. Having the currency rise in value over time is not healthy for a currency, it's healthy for speculators. Let me cite the link at the bottom of this message to address this perspective.

"Which means that the current price reflects the market's prediction of future price."

Agreed, but it's highly speculative. I consider it a fact that any businessman that looks at bitcoins will refuse to sign a long term contract that uses the currency, unless he's convinced he'll be on the winning side. Thus the situation now requires a sucker in order for the transaction to succeed. This isn't healthy for a currency. For short term transactions, I don't see a problem with bitcoin. For my use case, this is the fatal flaw.

Joel Katz then said:

"The issue is what happens in the future if all bitcoins have been generated and bitcoins are a well-established means of payment. In that case, deflation will be predictable."

I agree, but I claim deflation has already occurred because of the delta between demand and supply. All coins dont need to be created, only a delta needs to happen, and it could be both a positive and negative delta.

"Of course, there will never be perfect prediction. But the fact that most people will generally agree on at least what is likely to happen and that such predictions will not change radically over short periods of time ensure a stable price. (And the premise of the question is that we all know bitcoins, if they survive that long, will ultimately be deflationary. If that premise is false, there's no problem. If the premise is true, the market will be efficient to the extent it's true, so still no problem.)"

Good point, but a competing digital currency for those that want stability could arise, if there is a demand for it.

Bizzy then commented, and I agree 100%.

Joel then commented:

" I agreee. That's not the case right now. The question is about a future time when that is the case, when bitcoins are stable, when all (or most) of the coins are mined, and so on. Right now, in two years bitcoins might be worth nothing or $5,000 each."

Deflation has happened already. It was fueled ultimately by an increase in demand for bitcoins and a limited supply. I bet more towards the $5000 each statement.

Johnyj commented:

"Monetary policy control only works with a currency which is decreasing in value"

Disagree. If demand for the currency were to drop then government could remove some from the market. Take a company doing a stock buy back for example, same approach. It's ideal when the company has the funds and the price as dropped. That's in essence the exercise of monetary policy over the stock value by a contractionary policy (contract the supply).

"But if people are hoarding the currency, then most of the added money supply will become their saving, and the monetary policy could have very little effect. "

Disagree. If the hoarders know they will be punished, they will be less likely to hoard. As they see new currency being added, their confidence in the success of their hold stragegy will drop. Monetary control serves as an important psychology tool because people know it exists and can be exercised if necessary. With bitcoin, this is not the case, we all know it can't be exercised. Which is in effect one of the main reasons for its success, but for long term contracts this is a serious problem.

SUMMARY

Let's take the Swiss for example. The structure of their economy is such that they must have a stable currency, after all banking is their biggest sector. Inflation is very very low for Swiss Francs. It's an example of stability.

Therefore, if I were to issue a 30 year bond today, I'd want to be paid in Francs. The reason why is that I bet the US govt will inflate their way our financial problems. Yet the swiss couldn't get away with it.

For my use case, the 'economy' will be like Switzerland where stability is mandated, else there are winners and losers more so than satisfied parties whom have completed long term contracts. There is a great reduction in stress when you have confidence in the long term prospects of the currency.

So I'm researching to try to understand if monetary controls could be added to a p2p design like bitcoin, and I think they can. The controls would be variables in the protocol that enabled expansionary and contractionary policy. Note that I don't believe the stability of the swiss franc would be achieved, and the policy controls would not be god like, as they would involve voting by the community, but the community would be motivated for stability by the nature of the use case.

"An alternative is technically possible through revised software. The supply of Bitcoins could grow in proportion to the total value of transactions undertaken using the system."

But what happens then? Bitcoin will become more like the currency that we are using today (the money supply is decided by FED through carefully monitoring CPI and other indicators). FED members are already very wise if not the wisest person on the earth, if they can not decide what is the proper amount of money supply required, how come a P2P voting can generate a better result? We need a more sounding solution to decide the amount of money supply. Maybe a fixed percentage increase every year.

Actually the more I think about this problem, the more I realized how inteligent the FED is.

Disagree, because there is no accurate mechanism today to predict the future value of a bitcoin. For example, if the DEA took down a major money transport network (not laundering) tomorrow, the demand for bitcoins could spike. The market would know this I feel, therefore nobody in their right mind would accept a long term contract that had bitcoins as the currency. That's the essence of the problem I see with bitcoin, it's for short term transactions only because of a lack of confidence in the future stability of the currency.

I completely agree that until the behavior of bitcoins is reasonably predictable over at least the moderate term (3 years or so), they will not be useful for many of the applications of a currency because, if nothing else, prices will not be able to be stably denominated in bitcoins. But for those same reasons, the deflation won't do any harm. Businesses won't be dependent on loans denominated in bitcoins and so on anyway.

Quote

Deflation has happened already. It was fueled ultimately by an increase in demand for bitcoins and a limited supply. I bet more towards the $5000 each statement.

Right, but that was because of growth in popularity, not the deflation built into the bitcoin system. Bitcoins can't keep growing in popularity that way forever, you run out of people. So it's not a long-term threat to the viability of bitcoins.

I only disagree if the claim is that the deflation built into bitcoins represents a reason bitcoins can't be used long-term as a viable currency.

I am an employee of Ripple.1Joe1Katzci1rFcsr9HH7SLuHVnDy2aihZ BM-NBM3FRExVJSJJamV9ccgyWvQfratUHgN

But what happens then? Bitcoin will become more like the currency that we are using today (the money supply is decided by FED through carefully monitoring CPI and other indicators). FED members are already very wise if not the wisest person on the earth, if they can not decide what is the proper amount of money supply required, how come a P2P voting can generate a better result? We need a more sounding solution to decide the amount of money supply. Maybe a fixed percentage increase every year.

Bitcoin would become more like regular currencies in that it would have monetary policy tools.

As for it a p2p design could even match the effectiveness of the FED, well, that's the biggest question of them all in my opinion. You hit the nail on the head.

Joel Katz said:

Quote

But for those same reasons, the deflation won't do any harm. Businesses won't be dependent on loans denominated in bitcoins and so on anyway.

Deflation will do harm in that it will exclude many types of transactions from being done with bitcoins. Business won't be dependent on loans in bitcoins simply because no lender would provide a loan in bitcoins.

Quote

Right, but that was because of growth in popularity, not the deflation built into the bitcoin system.

Disagree. The deflation built into the system is the lack of an expansionary monetary policy tool beyond what is set by the algorithm. Couple that with the increase in demand and you have a large delta between supply and demand. Supply could not be increased to meet demand, thus prices rose.

I think bitcoin is awesome, but I also think it trades one set of problems for another. So my challenge is both to determine if a form of bitcoin with some monetary policy is technically possible, and if it's desirable. Perhaps this form of democracy, where the masses vote on monetary policy, isn't all that wise for general use. Perhaps it could only work among businesses, and even then there would be motivation for speculation and such.

Disagree. The deflation built into the system is the lack of an expansionary monetary policy tool beyond what is set by the algorithm. Couple that with the increase in demand and you have a large delta between supply and demand. Supply could not be increased to meet demand, thus prices rose.

That's virtually impossible. If people know that demand was going to increase, they'd want to hold the currency. So demand will already have increased because of the expected future increase. But if demand has already increased because of a future increase, then there won't be a future increase.

This is again the same erroneous reasoning that "bitcoins are worth X today, and they're have some extra value because demand is going to increase". Or, to put it more simply, it's saying "nobody will want bitcoins because the demand will be too high".

I am an employee of Ripple.1Joe1Katzci1rFcsr9HH7SLuHVnDy2aihZ BM-NBM3FRExVJSJJamV9ccgyWvQfratUHgN

Deflation will do harm in that it will exclude many types of transactions from being done with bitcoins. Business won't be dependent on loans in bitcoins simply because no lender would provide a loan in bitcoins.

I disagree that no lender would provide a loan, but it would require some careful thought. Lenders currently provide loans in unstable financial environments - they just adjust the interest rate to suit the risk. Obviously no lender is going to say "I'll lend you 20BTC now, and you pay me back 20BTC in 2yrs time" though - they'll still want interest. The biggest risk at the moment is on the borrower's part, because the price can spike upwards by an unlimited amount (meaning they may have to pay back many times the original sum), whereas a downward trend has $0.00 as a lower bound.

Disagree. The deflation built into the system is the lack of an expansionary monetary policy tool beyond what is set by the algorithm. Couple that with the increase in demand and you have a large delta between supply and demand. Supply could not be increased to meet demand, thus prices rose.

That's virtually impossible. If people know that demand was going to increase, they'd want to hold the currency. So demand will already have increased because of the expected future increase. But if demand has already increased because of a future increase, then there won't be a future increase.

This is again the same erroneous reasoning that "bitcoins are worth X today, and they're have some extra value because demand is going to increase". Or, to put it more simply, it's saying "nobody will want bitcoins because the demand will be too high".

My concern is that bitcoin is not usable for long term transactions, which is what my project is. For this use case, regular currency is a better choice. So in effect, for this group of users, indeed nobody will want bitcoins because the demand will be too high. This assumes they judge it a success like I do, and predict more use for it.

Deflation will do harm in that it will exclude many types of transactions from being done with bitcoins. Business won't be dependent on loans in bitcoins simply because no lender would provide a loan in bitcoins.

I disagree that no lender would provide a loan, but it would require some careful thought. Lenders currently provide loans in unstable financial environments - they just adjust the interest rate to suit the risk. Obviously no lender is going to say "I'll lend you 20BTC now, and you pay me back 20BTC in 2yrs time" though - they'll still want interest. The biggest risk at the moment is on the borrower's part, because the price can spike upwards by an unlimited amount (meaning they may have to pay back many times the original sum), whereas a downward trend has $0.00 as a lower bound.

From what you're describing, I conclude another currency would be used. To me bitcoin is best compared to gold, except easily tradeable and storable. Gold isn't an ideal currency (deflation being one reason), but it sure is a great hedge against inflation. To provide a loan in bitcoins entails a lot of risk, mostly for the obligee if it's predicted that demand for bitcoins will rise in the future at a greater rate than their creation. However, if the obligee were to feel bitcoin will implode, then they will feel they're getting a good deal. Either way, stability of the currency is not there. Having a stable currency is good for an economy that uses it.

Also, I've found my consultants, so I'm going to jump out of this thread now.

So far I'm concluding that bitcoin is awesome, but not for all all uses. I'm also concluding there is no current solution for what my project needs. Bitcoin with monetary control and stability, with a goal of being a digital swiss franc, is what I'm looking for. Wish me luck, because I'll need it.

My concern is that bitcoin is not usable for long term transactions, which is what my project is. For this use case, regular currency is a better choice. So in effect, for this group of users, indeed nobody will want bitcoins because the demand will be too high. This assumes they judge it a success like I do, and predict more use for it.

Your concern is valid. It would be very difficult to enter into a long term transaction today that was denominated in bitcoins. There's a non-negligible risk that in three years bitcoins as we know them today will no longer exist as a means of exchange.

The only thing I can think of, which likely would defeat the entire purpose of whatever you're doing, would be to have a backup clause. The backup clause would say that the contract switches to being denominated in dollars if bitcoins are no longer actively exchangeable for US dollars (or whatever currency is appropriate for you) between a certain set of exchange rates (say $1 to $1,000).

I am an employee of Ripple.1Joe1Katzci1rFcsr9HH7SLuHVnDy2aihZ BM-NBM3FRExVJSJJamV9ccgyWvQfratUHgN